What To Expect From Bernanke Tomorrow In Front Of Congress

Commentary for Wednesday: The economic and financial outlook remains cloudy. As such, we doubt Mr. Bernanke is going to say anything substantially different than what we gleaned from the June 22-23 FOMC minutes that were released last week. The economic forecasts that accompany the Chairman’s prepared remarks will be identical to those in the minutes. Since the June meeting, stock prices are down about 2-3%, high grade spreads are little changed but money market conditions have improved, owing to strong demand for European sovereign debt. This is evident from 2-year swap spreads which continue to tighten—they are well inside 25 bps, down from a high of 52 bps in late May and around 35 bps at the June meeting. The improvement in short-term funding is one development Mr. Bernanke could cite if we wanted to sound upbeat on the prospects of improving financial conditions. However, the economic data on balance have been softer than expected since the June meeting—for example, employment, retail sales, industrial production, housing starts and consumer sentiment were all soft. We marked down our estimate of Q2 real GDP growth from +4.0% to +3.0%, although most of this was due to less inventory accumulation. Mr. Bernanke will probably highlight the recent weakness in the data as a key factor behind keeping interest rates near zero and for keeping the Fed’s balance sheet bloated. We continue to be more optimistic than many of our peers, because despite some dreadful economic data, the underlying health of the corporate sector remains intact. Profits are high and rising, margins are expanding, and companies have dramatically cut labour, capital and inventories arguably by the most on record. For the economy to continue to expand, the corporate sector has to continue to spend and ultimately increase labour demand. The fact that capital spending has been growing at a double-digit pace is encouraging because we have never had a robust capex cycle without ultimately experiencing relatively strong employment growth. We do not believe companies are spending on capital investments at the expense of labour for two reasons: One, the trend in capex tends to lead the trend in hiring, and it is still early in terms of the recovery in the former. Two, companies need people to operate the capital being purchased. For example, new orders for computers are up 16% year to date. Surely, companies will need people to operate this equipment.

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